Hong Kong’s government has proposed codifying the tax authority’s new transfer pricing rules into law, requiring Hong Kong to comply with the BEPS minimum standards and introducing new requirements such as country-by-country reporting (CbCR).
Hong Kong previously relied on case law, notes issued by the Inland Revenue Department (IRD) and other provisions in the Hong Kong Inland Revenue Ordinance for transfer pricing rules. Codifying this legislation into law means there will now be a proper, legally binding framework around transfer pricing rules.
“Prior to the gazetting of the new TP rules, the IRD informally required all companies to ensure that their related party transactions were conducted on an arm’s-length basis. Under the new rules, specific companies meeting certain thresholds are required to prepare formal transfer pricing documentation,” Paul Dwyer, head of international tax and TP at Dezan Shira, told TP Week.
However, non-residents who carry out business activities in Hong Kong could face permanent establishment (PE) risks under the new legislation.
The new TP rules codify the manner in which PEs should be taxed having regard to transfer pricing principles, said Pierre Chan, tax partner at Baker McKenzie in Hong Kong. “Non-residents that carry out business activities in Hong Kong should examine their tax affairs to see how and whether the new rules may affect them,” he told TP Week.
For a resident of a jurisdiction that has a double taxation agreement (DTA) with Hong Kong, the relevant provisions under the DTA will determine whether there is a PE. For a person who is not resident in a DTA territory, the bill lays out a fixed-place test and an agency test for determining whether there is a PE. The bill also clarifies that preparatory or auxiliary activities do not constitute a permanent establishment.
More audit activity
The new TP rules stem from the IRD’s focus on preventing tax advantages from being obtained through non-compliance with the arm's-length principle. “We have already seen increased audit activity in this area, post codification of the new TP rules, and expect this trend to continue,” Steven Sieker, chair of Baker McKenzie’s Asia Pacific tax practice told TP Week.
“One consolation is that the new TP rules will operate based on OECD principles that multinational taxpayers are familiar with and are, in the most part, consistently applied in most countries.”
Conducting solid up-front TP analysis and being consistent when evaluating and documenting compliance with the arm’s-length standard will become increasingly important, he added.
Despite this, the new rules should overall be good news for Hong Kong’s business environment as they will improve certainty. Advance pricing agreements and mutual agreement procedures are also available under the new rules, although not many taxpayers have showed an interest in this yet.
“I would expect the TP rules to provide a greater degree of certainty on how transfer pricing principles will be interpreted and applied in Hong Kong, which will be positive for the business and investment environments,” Steven Carey, transfer pricing managing director, Duff & Phelps, told TP Week.
The new TP rules also provide mechanisms to facilitate cross border dispute resolution. “These changes are seen as positive steps to increase the avenues of appeal for taxpayers in managing their tax exposure across multiple jurisdictions,” Chan said.
